CLIMATE:

Offsets could make up 85% of Calif.'s cap and trade

When can 8 percent also mean 85 percent? Only in the convoluted world of climate law.

Both numbers attempt to sum up the impact of offsets, a controversial part of California's pending cap-and-trade program. Picking which one best applies is more than a debate over digits.

Starting in 2013, California's landmark law will impose cap and trade, a system requiring businesses to account for greenhouse gas pollution. Companies will buy and sell allowance permits for their emissions. But they will also have the option of using offsets, investments in forest preservation and other efforts that pare carbon.

California argues cap and trade needs offsets to keep costs low. Environmentalists warn the numbers stack up in a way that threatens the success of the plan.

"The offsets program is a huge trap door at the bottom of the cap-and-trade program that the entire cap-and-trade program could fall through," said Barbara Haya, a consultant for the Union of Concerned Scientists. "If we want to have a cap-and-trade program that's successful into the future, we can't have a giant trap door at the bottom."

The Golden State plans to limit offsets to 8 percent of a business's total reported greenhouse gas emissions. Some environmental groups say that number belies the size of the offset option.

The 8 percent limit, green groups said, translates to a much larger percentage of the carbon cuts mandated under the plan. Offsets will potentially make up 85 percent of all greenhouse gas reductions in the program from 2013 through 2020, a level some environmentalists see as perilous.

The state agrees that hitting that 85 percent level for offsets is possible but said that it is an improbable worst-case event.

"Under one scenario it could be accurate," said Rajinder Sahota, manager for the climate change program operations at California's Air Resources Board (ARB). "But we believe the scenario under which that 85 percent would be accurate is unlikely to occur in California."

Offsets and the overall shape of the cap-and-trade program have significance beyond California. The Golden State is rolling out climate rules that it hopes will serve as a model for other states and even the federal government. Congress in 2010 let die climate legislation that included cap and trade.

In California, offsets are a major point of disagreement for environmental groups, ARB and businesses that will be part of cap and trade.

Some environmental groups see offsets as problematic, arguing that people will find ways to get paid for projects that don't significantly cut carbon. As well, they said, the option of offsets keeps businesses from making plant improvements that would trim greenhouse gas pollution.

"It should be a very minimal amount of offsets with very rigorous controls," said Dan Kalb, California policy manager for Union of Concerned Scientists.

The current proposal from ARB, Kalb said, "is a cap-and-offset program. It's not a cap-and-trade program."

ARB and businesses argue a healthy offsets program is essential.

"From a public policy point of view, California has decided that it's really not that important what that percentage is as long as they make the reductions they promised they would make," said Evan Ard, managing director at Evolution Markets, a broker in the U.S. carbon market.

"Does it really matter if 85 percent of the reductions come from offsets?" Ard said. "The goal is to reduce [greenhouse gases] to a certain level by 2020. The goal isn't necessarily to get sources to make certain type of reductions. [ARB is] offering more flexibility to these facilities to meet these targets."

Instead of asking whether offsets will be 85 percent of reductions, Ard said, "the more relevant question is: Are the offsets going to be able to act as an efficient means to control costs? If people use them fully, they can be."

Removing offsets from cap and trade "would almost double the price of compliance in the program through 2020," ARB's Sahota said.

ARB is putting many restrictions in place to ensure standards are met, she said. To qualify as an offset in California's cap and trade, a project needs to show that it provides a permanent reduction of greenhouse gases. It must take place independent of other motivations or requirements, or what is known in offset parlance as "additional." There are other rules as well.

Because of those restrictions, there are questions about whether there will be enough qualifying offsets to get anywhere near that 85 percent level some environmental groups fear, said David Hunter, U.S. director for the International Emissions Trading Association (IETA), an association for companies that support cap and trade as the most effective way to reduce carbon emissions.

"This is a theoretical massive amount of offsets that could be credited into the system," Hunter said, but in reality the number probably will be much lower as the state restricts offsets at the beginning to four types. "Those four methodologies would not yield anywhere near the tons to come close to the 8 percent [of total emissions] limit."

Both sides of the offsets argument agree that the stakes are large.

Cap and trade needs to succeed, they said, for California's climate law to spread to other places, a stated goal of the legislation, A.B. 32, that established the program. California alone is not going to abate climate change, said Gary Stern, director of market strategy and resource planning at utility Southern California Edison.

"If we can show how to do it well and provide leadership that others can follow, then we can make a difference," Stern said.

Differing numbers

Both 8 percent and 85 percent refer to the portion that offsets could take up in California's cap and trade. The difference in which one applies depends upon what numbers go into the math formula.

The state often frames the maximum allowable offsets as a percent of "compliance obligations," a dense phrase roughly meaning a business' total reported greenhouse gas emissions. If a business discharges 100 tons of carbon in a year, for example, it could use offsets to cover 8 of those tons.

But that 8 percent limit on offsets is not calculated against how much companies will need to pare their greenhouse gas levels each year. That's where critics say it gets sticky.

There are not mandates on each company to cut carbon certain amounts. Instead, the state will issue allowances with each one covering 1 metric ton of carbon dioxide equivalent. The number of those will fall in each compliance period, starting in 2013-2014 with a drop of 2 percent of all emissions under the cap. It is up to each business to decide how to deal with the falling number of allowances.

Looking at offsets through the prism of reductions, Union of Concerned Scientists said, the numbers get much bigger.

Using the same scenario of that business with 100 tons of emissions, if in the first compliance period it has allowance permits for 98 tons, it could use the allowed 8 tons of offsets to cover all of its needs. (Businesses cannot carry over extra offsets.)

Calculating with the planned reductions through 2020, Union of Concerned Scientists said, the offsets become 85 percent of the carbon cutbacks over that period.

"[ARB] will claim that the more offsets you allow, the more quote unquote flexibility you allow, the more potential to lower compliance costs," Kalb said. "Offsets by definition are very risky. They have to be additional. It's hard to prove additionality. The more you allow compliance through offsets, the more risk you are incorporating into your cap-and-trade program."

ARB argues that the 85 percent level is unlikely because hitting it requires not only that businesses use all of the 8 percent of emissions limit, but also that the program would need to burn through a pool of carbon allowance credits.

The state plans to set aside 4 percent of allowances -- the permits to cover greenhouse gas emissions -- in a reserve that businesses could access if the trading price rises to a certain level. That price starts at $40 per metric ton in 2013 and will go up each year until 2020.

The "price containment reserve" is meant to insulate businesses from price shocks. By setting aside 4 percent of allowances, the state effectively reduced the number of allowances by 4 percent through 2020.

ARB has done economic analyses that show the reserve shouldn't be hit, Sahota said. If those calculations are correct, she said, "51 percent of the reductions have to absolutely come from in-state California facilities that are regulated under cap and trade." The other 49 percent could come from offsets.

"If we've made a mistake and carbon reaches a price where the price containment reserve would need to be tapped," Sahota added, "then you could potentially be looking at up to 85 percent of the required reductions coming from the offsets."

If allowances from the reserve pool are added back in to cap and trade, there are fewer carbon reductions, Sahota said. That means offsets would then make up a larger portion of the total reductions.

Barclays earlier this year projected that allowance prices in California's cap and trade by 2018 could rise high enough that some of the reserve pool of allowances would be needed. Hunter with IETA said Barclays has predicted higher potential allowance prices than other forecasters.

Hunter believes it is unlikely offsets will even make up 49 percent of the reductions that ARB said would apply if the reserve pool is untouched.

"That 49 percent is making a half-dozen assumptions, most of which at this point seem impossible to come through," Hunter said. Given the restrictions ARB is placing on the offsets, he said, "I see no possible way you reach the offset cap."

Term switch?

Environmental groups say that it would be less confusing to refer to offsets as a percent of the carbon cuts companies must make. California has referred to offsets that way as well. A year ago it described the offsets limit as 49 percent of emissions reductions (ClimateWire, June 23, 2010).

Environmental groups believe ARB began calling the offset limitation a percent of total emissions last fall, around the same time that it created the reserve pool of allowances and effectively boosted how much of the carbon reductions that offsets could make up.

"That is actually the point at which they switched to how they were talking about it," said Brian Nowicki, California climate policy director with Center for Biological Diversity.

With that change in verbiage, he said, the number shrunk to 8 percent.

Sahota, however, said ARB has talked about offsets as a percent of emissions and percent of reductions "interchangeably," depending on whom the agency is addressing.

"There was never a formal decision or an informal decision to reframe the discussion in one way or the other in the program," Sahota said. "It's always been within the context of the group or the talk or the context of the discussion at hand."

The California proposal, if it is finalized, would not be the first to describe the offsets limitation as a percent of total compliance obligations.

The climate bill from Reps. Henry Waxman (D-Calif.) and Ed Markey (D-Mass.), which passed the House in 2009 and then stalled in the Senate, allowed offsets as a percent of emissions. In that legislation it was a stated overall limit on the tons of offsets that could be used in the program.

At the level of companies, that limit worked out to a maximum of about 30 percent of emissions in the first year, said Hunter with IETA. Unlike environmental groups who see California's offset plan as too generous, he sees it as parsimonious.

"The California program is much more stringent overall than Waxman-Markey," Hunter said. "California allows a quarter as many offsets, fewer types of offset projects, and less workable review provisions."

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